NEW YORK, Aug 16 (Reuters) - The dollar strengthened while U.S. and European stocks surged on Friday amid growing expectations the European Central Bank will cut interest rates to stimulate the economy and after China said it plans to boost disposable income to spur consumption.

Benchmark U.S. Treasury yields rose from three-year lows but government bond yields in the euro area hovered near record lows on heightened expectations of aggressive ECB easing soon to address growing concerns about recession risks.

The dollar hit a two-week high against the euro as expectations of ECB stimulus weighed on the single currency while bullish data showing a jump in U.S. homebuilding permits to a seven-month high also helped lift the greenback.

The euro pared some losses after Der Spiegel reported Germany's right-left coalition government would be prepared to ditch its balanced budget rule and take on new debt to counter a possible recession.

German government bond yields rebounded sharply but later pared some of the gains. The Finance Ministry declined to comment on Spiegel's report.

The rebound in equity markets buoyed investor sentiment, though it is hard to say the recent rout has found a floor despite cheaper prices, said Yousef Abbasi, global market strategist at INTL-FCStone Financial in New York.

U.S. banks are likely to get cheaper because European banks are likely to do so if the ECB doesn't put together a credible off-set plan for further negative rates for banks, he said.

"That's the concern. Despite some equities looking attractive the macro concern is giving investors a reason to pause and not so aggressively buy the dip," Abbasi said.

The Dow Jones Industrial Average rose 315.64 points, or 1.23%, to 25,895.03, the S&P 500 gained 42.1 points, or 1.48%, to 2,889.7 and the Nasdaq Composite added 133.39 points, or 1.72%, to 7,900.01.

The euro earlier slid to $1.1090, shy of a two-year low it set two weeks ago, on reports the ECB's Olli Rehn had suggested Thursday that a significant easing package was needed in September.

The dollar index rose 0.04%, with the euro down 0.09% to $1.1096. The Japanese yen weakened 0.21% versus the greenback at 106.36 per dollar.

The German bund was set for a fifth straight week of declines, Italy's 10-year bond yield was poised for its biggest weekly fall since mid-2018 and Spanish 10-year yields were on track for their biggest weekly fall since 2016.

The benchmark 10-year U.S. Treasury notes fell 14/32 in price to push yields up to 1.5741%.

Crude oil prices recovered from two days of declines after data on Thursday, showing a rise in U.S. retail sales, helped ease recession concerns. A bearish outlook from OPEC capped gains.

Brent crude rose 42 cents at $58.65 a barrel while U.S. crude traded break-even at $54.47 a barrel.